16 May, 2021 | The Week in Tax
- How the Aussie Budget affects New Zealand
- Is taxing capital gains at 39% fair?
- Progress on an international minimum tax rate
Transcript
New Zealand Budgets are usually exercises in political grandstanding and are the duller for it. While political grandstanding around Budgets isn’t confined to New Zealand, Budgets overseas often have some interesting new tax measures.
Tuesday’s Australian Budget was no exception. As Bernard Hickey pointed out supposedly conservatives the Liberal-National coalition government unveiled a AU$107 billion deficit spending plan for 2021/22 and expects to run deficits for the rest of the decade, building up a debt load of AU$1 trillion by 2024/25 or around 50% of GDP. This is at a time when the Labour Government here is concerned about a net debt to GDP ratio of 32% and has picked a fight with the public sector in the name of restraint. We live in strange times.
Other than splashing a lot of cash, the Australian Budget had a number of tax initiatives which would be viewed with envy from this side of the Tasman.
For starters, they included an additional AU$7.8 billion in tax cuts by retaining the low and middle income tax offset, and that’s been extended for another year. Now, remember, our personal tax thresholds have not been changed since 1st of October 2008. And the tax rates themselves haven’t been changed, with the exception of the new 39% rate, since 1st October 2010.
For businesses, the measures included extending the temporary full expensing of depreciable assets until 30 June 2023. Now remember, a similar measure here only increased the depreciable assets threshold for a write off or full expensing to $5,000 dollars, and that expired on 17th March.
The temporary loss carryback regime will also be extended by another year to 30 June 2023. And that enables businesses to offset losses against profits as far back as the year ended 30 June 2019. We have only allowed the temporary loss carryback regime for the March 2020 and March 2021. So, again, big difference in the approach.
There’s something else which is a bit of a worldwide trend called a patent box regime, which taxes income derived from Australian medical and biotech patents at 17% effective concessional corporate tax rate. The ordinary corporate tax rate in Australia is 30% (or 25% cent for SMEs). This new regime, which will start from 1st July 2022, is intended to encourage businesses to undertake the research and development in Australia and keep patents in Australia. And Australia is now one of over 20 countries, including the UK and France with this sort of regime,
There’s changes to employee share schemes and a Digital Tax Gains Tax Offset to promote the growth of the digital games development industry in Australia. And if you think gaming has little value, think again. The Kumeu based gaming company Ninja Kiwi was recently sold for over NZ$200 million.
Tax residency
However, probably the most significant change from a New Zealand perspective and one which will impact people here is the change in the tax residency tests.
From 1st July the primary test for individuals will be what is described as a simple bright-line test. A person who is physically present in Australia for 183 days or more in any tax year will be an Australian tax resident. Now, if the individual doesn’t meet that primary test, there’s a number of secondary tests that will depend on a combination of physical presence and what are described as a measurable, objective criteria.
As I said, this rule applies from 1st July, and so people who are making regular and frequent trips to Australia will need to keep in mind the impact of the new rules. Furthermore, the Australian Government is going to consult on expanding the newly revised residency test for corporates to include trusts and corporate limited partnerships. There’ll be consultation going forward on that. Watch this space.
So, a lot to unpick there and frankly, a lot more interesting than what I expect to see in next week’s New Zealand Budget. The key thing is I noted for New Zealanders is the residency test. So start tracking your days carefully and if in any doubt see an expert. It’s arguable that the terms of the double tax agreement between Australia and New Zealand may get you out of Australian tax residency because of what we call a tie break provisions which take you back to New Zealand. But still, there could be a few pitfalls in there which can be avoided with proper consideration.
Moving on, as everyone is aware, the top income tax rate increased to 39% for income over $180,000 with effect from 1st April 2021. An article in Stuff on Wednesday pointed out that a number of people were getting quite concerned about the impact of this on disposals of what may be capital gains – investment properties in particular – because we have a new Bright-line test as well, extended to 10 years.
Currently the position is, income or gains that arise from the sale of a property subject to the bright-line test is added to a person’s annual income and taxed at the marginal rate. That’s the rule New Zealand has always applied. And if you recall when John Cantin and I discussed whether in fact that was perhaps appropriate for taxing lump sums. The view of Inland Revenue was, as John summarised it, if there was no tax paid during the time the gains were accruing, it seems only fair to apply the rate at the time of disposal.
But 39% is, as the article pointed out, high by world standards. But there’s a trend in the world now to look at that issue. And this is something I discussed on The Panel on Wednesday with Wallace Chapman on Radio New Zealand.
Although 39% is high by world standards, it’s not entirely exceptional. Countries are now starting to look at the question of capital taxation, and they’re also looking at the very obvious move – if you have a differential tax rate for capital gains, then the temptation is for high income earners to have income treated as capital and subject to a lower CGT rate.
And the Office of Tax Simplification in the UK looked at this in November and produced a report. It suggested to the UK government that they might want to look at changing the tax rates there where the top rate for residential property is 28%, whereas the income tax rate is 45%. But one of the things that caught my eye in the OTS report was the extent to which very large amounts of tax on capital gains are paid by a relatively small amount of people.
The OTS noted that UK£8.3 billion of capital gains tax was paid by 265,000 people in the year to April 2018. That meant their average liability was UK£32,000. By comparison, for income tax purposes, 32 million people paid UK£180 billion, which meant an average liability of UK£5,800. So, in other words, there’s a lot of concentrated wealth going on there. So the OTS said that maybe we want to look at that.
And US President Joe Biden has said the capital gains tax rate that applies for people earning more than US$1 million should be the top personal tax rate of 39%.
Now, coincidentally, or while this is going on, the OECD released a paper on inheritance taxation in the OECD countries. Its summary was that countries should be looking at inheritance tax, estate and gift taxes in general, as having the potential to play a role in the current context of recovering finances in the wake of covid. It also points out that wealth inequality is high and inheritances are unequally distributed across households.
Now, what really stood out in this OECD report was,
“the case for inheritance taxes might be strongest where the effective taxation of personal capital income and wealth tends to be low”
which would almost be as if the OECD were looking at New Zealand and saying, “Yeah, we are talking about you.” Because we don’t have a comprehensive capital gains tax, we don’t have estate taxes, we don’t have gift duties, and we don’t have stamp duties. The absence of any one of those make us unusual in world terms.
So plenty to consider in that. We won’t see any of this coming through from our Government. But I do wonder, watching the world, whether the trends that are developing there around the taxation of capital will emerge here. The OECD report really goes into how much concentrated wealth there is and the issues around that. It is saying, for example the wealthiest 10% of households own half of all household wealth on average across 27 OECD countries for which data were available.
And the wealthiest one percent, own 18% of household wealth on average. Financial wealth is particularly concentrated. The wealthiest 20% of households may own half of all real estate wealth, but they own nearly 80% of all financial wealth. So there’s a lot going on overseas looking at issues which we’re not immune to down here.
Although we’ve had the Tax Working Group report, I thought that the question of wealth taxation was something that was largely sidestepped. Obviously, they went with a capital gains tax proposal which was knocked out. And by the way, to circle back to the question of the tax rate that applies. One of the results if the capital gains tax proposal by the Tax Working Group had been implemented, by broadening the tax base it would have enabled the tax rate to stay at a 33% level.
Minimum tax rate for MNCs
And talking about tax rates elsewhere, there’s still a debate going on around international minimum corporate tax rate and progress appears to be being made on this. But one commentator has suggested that ultimately the rate that will be chosen for this minimum tax is probably going to settle very close to the Irish corporation tax rate of 12.5%. They’ve had it for decades now. And it’s why the Irish are pushing back very strongly against suggestions that this minimum tax should be 21%.
So the author somewhat cynically said, well, if we’ve got to go with a minimum tax threshold, then really, when you think about it, you’re looking at the Irish tax rate. He noted that the Treasury officials in America, when they were reporting on this to Congress, started talking in terms of a minimum tax. And he saw that as pointing to that they really were thinking in terms of a lower tax rate than initially suggested. Anyway, that’s going to be a matter of debate, but progress is being made on this point. So it could be by the end of the year, some form of minimum global corporate tax rate has been set and if it is around 12.5%, don’t be too surprised.
Well, that’s it for this week. Next week is the Budget and so we will have a special on that. In the meantime, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients.
9 May, 2021 | The Week in Tax
The latest draft guidance for taxing crypto assets, and the latest tax audit claim stats from Accountancy Insurance
- Rethinking the taxation of property
- Inland Revenue releases latest crypto advice
- Inland Revenue audit activity
Transcript
In the wake of the government’s shock property tax announcements back in March, Inland Revenue has been preparing the relevant discussion documents and papers for consultation.
The range of matters to be addressed is formidable. What represents residential accommodation? What is the definition of a new build? How do we determine what proportion of a mixed-use loan can be deductible? What about the treatment of interest treated as non-deductible for a property, the sale of which is taxable under the Bright-line test or some other provision? Do we still need loss ring-fencing? The list goes on.
It’s a long and frankly daunting list, the inescapable conclusion of which is that no matter how hard Inland Revenue tries, and I know they are trying to make it as simple as possible, the tax treatment of residential property will ultimately be vastly more complex.
And that’s before you add matters such as preparing for climate change mitigation, earthquake strengthening costs, leaky building repairs and costs relating healthy home standards.
It’s no wonder some residential property investors are considering selling up completely or downsizing their investments.
And watching all this, I’ve been increasingly coming round to the view that maybe it is time to rethink completely how we tax residential rental investment property.
And maybe instead of trying to shoehorn the proposed changes into the existing tax framework we should go back to the basics and adopt the approach that was considered by the last Tax Working Group, but ultimately rejected in favour of a comprehensive capital gains tax. And that is taxing property on a deemed return basis.
Now, what the Tax Working Group looked at is replacing the existing taxation approach on rental income and instead determining taxable income based on the net equity at the beginning of the tax year, applying a rate of return, and taxing this amount at the investors relevant tax rate.
So, for example, Tina owns a residential rental investment property worth one million dollars at the beginning of the income year. That’s funded with 300,000 dollars of debt giving equity of $700,000. Tina’s marginal rate is 33%. The deemed rate of return is set at 3.5%.
Tina’s tax bill for the year would be $8,085 dollars, i.e. $700,000 – that’s the net equity – times the deemed rate of return of 3.5% times her marginal rate of 33% percent. She would not pay any tax on the actual rental income she derives from that property.
Now, this deemed rate of return is an idea has been around for some time. It was first suggested by the Mcleod Tax Review in 2001 when they referred to it as the Risk-Free Rate of Return. This was subsequently adopted for the Foreign Investment Fund (FIF) regime, which came into place with effect from 1st April 2007. The FIF regime has what they call the fair dividend rate, which was set back then at 5% and remains at that level today.
Although hugely controversial, and not terribly popular on its introduction, we’ve all learned to work with the FIF regime and the fair dividend rate. It has its merits in terms of conceptual simplicity. Also for investors, if your return exceeds 5%, your taxable income is capped at 5%. So that’s a win. It does away with the need for distinctions between what is capital and revenue.
And it would take into account some of those factors I mentioned earlier on. The devaluation of a property because it’s found to be a leaky home, or it has climate mitigation risks. Alternatively, the costs of earthquake strengthening would improve the value of the asset. The value of the building will rise therefore the Government benefits and it doesn’t need to worry about the questions we’re seeing right now that I mentioned right at the top of the podcast.
Now, it so happened that myself and Professor Susan St John talked about this particular proposal on a broader aspect at a Fabian Society presentation we made last week. And the more I think about the issue, we saw a change of approach as perhaps an answer to dealing with the housing crisis or a tax answer because ultimately the answers to the housing crisis are multiple and obviously include more supply. But tackling the demand side from the tax perspective was one area where we thought it was worth considering.
I deal with these issues as clients come to me with what are we going to do in this circumstance and that circumstance? And as I drill down into the detail of the impact of the reforms, I cannot help but wonder that it is time to have a really good look at what the Tax Working Group proposed and maybe think about adopting that, rather than trying to shoehorn existing concepts into an increasingly strained tax system.
The Tax Working Group also did some revenue impacts on their proposal. They were quite interesting, in that they figured that for the year ended 31st March 2022 – which is the first year this could have come into place – if they had applied a 3.5% rate of return, the Government would have raised close to one billion dollars.
Now that was ahead of the expected amount of revenue that could have been raised under the capital gains tax proposal that the Tax Working Group actually finished up running with. Just for comparison, in the first year, the expected capital gains that would have come out under the Tax Working Groups proposal across all the asset classes was about $400 million and was roughly $50 million in respect of residential rental investment and second homes.
So the deemed return approach – which Susan and I decided to call “fair economic return”, would have been a better fundraiser for the Government initially. It’s something that we won’t see obviously in the coming budget. But I think it is something that policymakers should have a serious think about, because from what I’m seeing and hearing from discussions around how the new tax proposals are going to work, we’re heading for an incredible degree of complexity and we’re going to expect that complexity to be negotiated by people who are probably not, in all honesty, the most sophisticated of investors and do not have access to the best quality advice. It’s actually a recipe for tax pitfalls, not just for investors, but also for those who are advising them.
Taxing crypto gains
Moving on, the recent jump in house prices has had widespread ramifications, as we’ve been discussing, but in terms of rapid growth, it’s been far outstripped by the extraordinary rise in the market capitalisation of cryptoassets. The market capitalisation of virtual currencies has gone from US$354 billion in September 2020 to just under US $.8 trillion dollars at the start of April.
So it’s quite timely then that Inland Revenue has issued some guidance for consultation on a couple of matters which are in the cryptoassets world. These are draft questions we’ve been asked, and the first one is on the income tax treatment of cryptoassets received from an airdrop, and the second one is, I need to be careful how I pronounce this, the tax treatment of cryptoassets received from a hard fork.
Questions about the tax treatment of these two particular events have been raised for some time.
Now, as I’ve said previously, the pace of change in the cryptoassets world is quite extraordinary and that’s been enhanced by the volume of money that’s going into it, as evidenced by the dramatic increase in market capitalisations. So Inland Revenue’s original advice that they would consider most proceeds realised from the disposal of cryptoassets to be taxable, has been shifting.
But what happens in these peculiar events?
So an air drop is a distribution of tokens without compensation, i.e. for free, generally undertaken with a view to increasing awareness of a new token and to increase liquidity in the early stages of a new token project. So, for example, they might use it to increase the supply of a cryptoasset in the market, reward early investors or users, or just simply raise awareness of that cryptoasset by distributing it to holders of other cryptoassets.
Inland Revenue’s view of what happens here is that if someone receives an airdrop cryptoasset it’s taxable if they have a cryptoassets business or acquired the cryptoasset as part of a profit-making undertaking or scheme, provided services to receive the airdrop, and critically, the cryptoassets are clearly payment for those services, or receive air drops on a regular basis, and the receipt has hallmarks of income. In other cases, however, it’s not taxable.
Obviously, people who are mining for cryptoassets or running an exchange will be caught. If they receive airdrop cryptoassets, they’ll be taxable on that airdrop. But the argument now will arise for someone who’s what you may call “an investor”, who has been holding these assets for some time. They receive these airdrops randomly or they’ve been holding other assets. The argument might be that in those cases, the receipt of the airdropping cryptoassets, won’t be taxable.
What about if you sell an air dropped cryptoasset? Again, it’s taxable if the person has a cryptoassets business, they dispose of it as part of the profit-making undertaking or scheme or providing services to receive the airdrop or acquired cryptoassets for the purpose of disposing of them.
in relation to cryptoassets received from a hard fork, similar considerations apply. Now a hard fork is something that changes the protocol code to create a new version of the block chain along the old version. Then creating a new token which operates under the rules of the amended protocol, while the original token continues to operate under the existing protocol. I appreciate this is all very nerdy speak.
But for example, in July 2017 there was a hard fork of Bitcoin that saw the creation of the Bitcoin cash token alongside Bitcoin itself.
If you receive cryptoassets as part of a hard fork, again, Inland Revenue’s arguments are it will be taxable if someone holds the cryptoassets as part of a cryptoassets business or acquired the cryptoassets as part of a profit-making undertaking or scheme. And similarly, if they dispose of cryptoassets received after a hard fork, they will be taxable if the person has a cryptoassets business, disposed of them as part of a profit-making undertaking or scheme, acquired those cryptoassets for the purpose of disposing them, or acquire the original cryptoassets for the purpose of disposing of them. For example, the person received new cryptoassets through an exchange.
There are quite detailed rules on this so it’s going to pay to work through these issues carefully. But Inland Revenue is steadily expanding on the advice it’s giving on cryptoassets, which is good to see.
Consultation on these two items run through till 25th of May. The principles as applied here seem reasonable at first sight, but obviously when you drill down into them you might think maybe we want to tweak what Inland Revenue is saying.
But as I said earlier, if you’re a cryptoassets investor and you’re holding a lot of cryptoassets as an investment, as part of a general portfolio, you’re probably now in a stronger position to argue that air drops and hard forks are not necessarily taxable.
Inland Revenue audit claims rise +30%
And finally, you may recall that last year I spoke with the accountancy insurance provider Accountancy Insurance. They’ve just released some information about the latest tax audit claims for the year ended 31st March 2021. What they said is they saw policy claims increase 31% in the 2020-2021 financial year compared with the previous 2019-2021 financial year.
So what happened here is that Inland Revenue is clearly still active in reviewing taxpayers despite Covid-19 and the various disruptions that caused. Accountancy Insurance noted that GST verification claim activity increased by 48% year on year and income tax related claim activity increased by 67% percent over the 12 months to March 2021.
Now, apparently, what drove those income tax claims were two specific projects, which we’ve discussed beforehand here, that Inland Revenue started in late 2020; a Bright-line test property initiative and another initiative on the automatic exchange of financial account information under the common reporting standards.
Interestingly only about 5% of claims related to rental property, employer obligations and other matters. Only just over 1.3% of claims related to full scale audits with just under 10% were what we call client risk reviews. But 55% of all claims made related to GST verification and just under 28% relates to income tax returns.
So, this comes out just as interesting news has just started to break that apparently Inland Revenue is going through another round of restructuring and reducing its audits investigation staff. I find it strange that they’re doing that at the time when they clearly can ramp up their activity. But this Accountancy Insurance report shows is that Inland Revenue is not dead or resting, but is still very active in this space. And you should expect that if you file a GST return with a significant GST refund claim, it will be subject to some scrutiny.
Well that’s it for today, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients.
2 May, 2021 | The Week in Tax
Terry Baucher and John Cantin explore that and other thorny tax issues, and the side-lining of our internationally respected tax consultation process
Transcript
Kia ora koutou katoa, it’s Friday, 30th of April 2021 and welcome to The Week In Tax. I’m Terry Baucher Taxpert and director of Baucher Consulting Ltd., a tax consultancy helping individuals, small businesses and professionals navigate the tax minefield.
My guest this week is John Cantin, a vastly experienced tax partner with KPMG, who probably is one of New Zealand’s leading tax gurus. John has written one of the most astute analysis of the Government’s recent proposal to limit interest deductions that I’ve seen. I recommend you read it because it cuts right through the emotion and gets to the heart of the issue.
Here’s the opening to his post.
“The Government’s decision to deny interest deductions to residential landlords has generated much heat. A particular focus has been its labelling as “closing a loophole”.
Quite clearly current law says interest is deductible for property investors who derive taxable income. (One Twitter commentator quotes the relevant section of the Act). At a technical level, interest deductions are not a loophole.
However, the outrage misses the point.
Simply, (most) voters see a residential landlord deducting interest and making non-taxable gains. In the language of politics, that is a loophole.
“Loophole” is shorthand to describe the policy problem. Voters understand it at this level. (Equally, in the same property context, “Mum and Dad investors” and “speculators” is the language of politics and not tax policy).”
Morena John, thank you for joining us.
John Cantin
Thank you for those kind words of introduction, I appreciate it very much.
Terry Baucher
Not a problem, John, really appreciate you joining us. So what is the policy problem?
John Cantin
The policy problem in a nutshell is how do you deal with dual purpose expenditure. Money that you send out the door that has two purposes. That’s very much the issue with interest on money borrowed to acquire a residential property.
TB
Now, that’s perfectly encapsulated and this is a long-standing problem, as you mentioned in your post, isn’t it?
John Cantin
It has been around for a long time period. And at a technical level, it’s the difference between use and purpose. So the interest deduction rules ask how have you used the money? Whereas when you’re looking at what’s driving the purpose of the interest, that’s a different question.
TB
Indeed, that’s actually a very nice distinction and a proper one to bring in. And so how much of a surprise to you was the Government’s move on this?
John Cantin
Completely out of the blue in the sense that nothing leaked or anything of that nature ahead of time. No indications, to that extent it’s a surprise. But as you say, this issue has been around for a long time. It goes back to some cases that are referred to in my article called Pacific Rendezvous and others.
If you go back to the late 90s, it was also a policy problem of what to do with interest deductibility because of moves by Inland Revenue to state what they thought the law was at the time, which were going to cause practical compliance problems for companies and others. So it does keep raising its head. And you think back to the Muldoon era interest limitation rules and the recovery rules back in the day and in the 80s, it has been around for a long time.
TB
You mentioned the Pacific Rendezvous case, the Court of Appeal decision from 1986. What actually happened in that case?
John Cantin
Relatively simply, it was, if I remember correctly, a motel Terry, and the owners had decided that they wanted to sell the property, but needed to do some, let’s call it refurbishment, redevelopment. They borrowed money, which was helping to let them do that. And they claimed all of the interest because it was used in operating the motel.
Inland Revenue said, well, actually, some of that interest relates to the sale, and you shouldn’t get a deduction for the whole lot. Court of Appeals said it’s all used in running the business, so it’s 100% deductible. So that’s where our use versus purpose question comes in. 100% use means 100% deductible, even if it will have a slightly different outcome as well or serve a different outcome.
TB
That decision in 1986 was right in the middle of the major tax reforms being led by Roger Douglas and Trevor de Cleene. Looking back it seems to me that with all the work going on around that time, it was a very, very clear expectation that the reforms would lead to some form of comprehensive capital taxation, capital gains tax. Call it what you want. Against that background, the Pacific Rendezvouss decision seemed quite logical because it might have been playing in the background of the Court.
But after March 1990, when David Caygill, then Finance Minister, pulled the pin on capital gains tax proposal, that decision reinforced and put in place an anomalous treatment, or loophole which sooner or later would need to be addressed. Would that be a fair assumption of how we’ve got to this position?
John Cantin
I think that the technical response is that the Court made a decision based on use rather than purpose. The Commissioner’s argument wasn’t entirely surprising because the interest deduction is to the extent it’s used, so that that suggests some sort of apportionment.
I’m not sure that the courts actually had in mind that there might be a law change. With the greatest respect, I think, Terry, you might say that our courts are not great tax policy makers. You know, I’ve spent too much time on the Commissioner’s draft update on section BG 1 recently. And they’ve taken 100 odd pages to try and interpret what the Supreme Court said in the Ben Nevis decision. So I’m not sure that our courts are great at tax policy.
Occasionally they will point out errors in the legislation and things that might need to be fixed, but I don’t think they make decisions based on what the policy ought to be. But you’re absolutely right, that context of what was happening in the late 80s and The Consultative Document on the Taxation of Income from Capital, a comprehensive capital gains tax was the direction of travel amongst all of those reforms.
And that would certainly reduce the tension between use and purpose, because ultimately whether it was used in the business or used in the business and seeking a capital gain, well then it didn’t matter. You got a deduction for it – it would have made no difference.
But it hasn’t really been revisited as a particular issue specifically, except for the residential loss ring-fencing, that has the effect of limiting interest deductions, although not just interest, of course. So, some of those measures can be seen as responses to that.
TB
Yes, and that sort of use and purpose is coming back a little bit in these announced changes although we haven’t got much detail to work with at the moment. But there was a hint that if a property was sold, which was subject to tax under either the Bright-line test or some other measure then interest deductions previously denied would become deductible. That seemed to be hinted at in the initial papers released on 23rd March. But that’s also something that’s going to be under consultation, so we’ll see shortly.
I suppose that leads us into this move by the Government which doesn’t really sit well within the Generic Tax Policy Process in that normally there would be a process of consultation, saying we’re thinking about doing this, what are your thoughts and feedback? And then the legislation works through issues papers and then into legislation. But that’s all been shortcutted.
Is that a concern for the Generic Tax Policy Process (GTPP) in general, or is it now dead or merely resting, to borrow a phrase?
John Cantin
Really big questions, Terry. Look, I sort of go back to where the GTPP started in the mid-90s out of Sir Ivor Richardson’s review of Inland Revenue. And a significant driver for that was the reaction to the entertainment tax, amongst others, introduced in the early 90s. That was a National Government changing the business tax rules. And many of its supporters were particularly unhappy about that change even though I suspect something was in the ether.
Richardson recommended the GTPP and I think ministers since have seized on that as a way of depoliticising tax policy, they find it useful to test their thinking. And occasionally they walk back from some of the rules.
But I think we need to remember that the GTPP is essentially political, that relies on the goodwill of ministers, officials and people like you and I actually contributing. I’m reluctant to say it’s either dead or merely resting because the GTPP serves to answer two questions. One is, is this the right tax policy and the second is how best to do it. And that call as to what you consult on will be made by different Governments at different times, in different phases so far.
For example, if I remember correctly, when the GST rate was increased to 15%, there was no consultation on that increase – the first question wasn’t asked. The second question about how best to do it was, and that was what was consulted on. I suspect in this case, asking the first question, the call was made. We’re just going to get a whole lot of people saying, no, don’t do it.
And that’s not really going to advance the process at all. I would have liked to have seen some consultation, because I don’t think 100% denial of a deduction is the right answer either. But we’re in that process now where the detail will be consulted on.
So you have an ability to answer the second question, how best to do it, does it actually meet the policy objective and can it be done better? So I don’t think it’s dead or resting. I think different ministers, different Governments make calls on which of those two questions they want to ask the question of. I have said to others I haven’t stood for any election at all and I doubt I’d get a vote, but those are the people that we voted in to make those calls. So you do have to sort of step back and say, well, that’s their call. They live or die by that every three years. That’s the call they make. And we need to just carry on with it.
TB
That’s a great point you made there, John. About the GTPP you referenced the increase in the GST rate. I think at the same time they that they withdrew depreciation on buildings completely, and repealed the loss attributing qualifying regime. And we got no consultation on either of those points as well. And that was the National Government. So both sides will do it and as you say, politics, that their job depends on it. They will have to make political calls and we basically have to suck it up, putting it crudely, that’s just a fact of life.
John Cantin
It’s a fact of life. I do remember, though, that with those changes to GST and depreciation, LAQCs, there was the Tax Working Group led by Bob Buckle sitting in the background.
So, all of those things were not entirely unpredictable. And there was some measure of floating of those ideas through that tax working group’s report. So, some of that stuff was in the in the ether, as I call it. It wasn’t entirely unpredictable, but decisions are always made politically, often for budget measures where budget secrecy says we’re just going to make a call.
TB
Actually, I must admit, when I started my career in Britain where budget surprises were very frequent, I’ll be honest, sometimes it’s nice to have a wee surprise in the budget, even if you’re scrambling around trying to sort it out afterwards. “What does this mean? Well, we’ll have to tell you.”
There was one thing about the announcement that did surprise me. There was a lack of detail supporting the fiscal costs of the interest deduction measure. That surprised me because landlords are meant to file disclosure forms an IR3R return which has a specific interest disclosure item. What was your view on that?
John Cantin
I think initially surprising. I think part of it suggests that this was, I won’t say necessarily hurried, but a decision that the lead time on was not particularly long. So, not unsurprising in that sense.
But when you do think about it, one of the risks with any estimate here is the final design is unknown at the time of the announcement. There will be discussions on what is a new build, there will be consultation on how you apportion between business and residential property borrowings. There will be rules around interest stacking, as they call it, for companies and other entities or shareholders and other entities.
So, the whole picture potentially is a little muddied, and I think one of the risks is you come out and say, well, it’s worth $600 million, and then when you design it, it’s worth $200 million. That criticism always seems to be played that you got the numbers wrong. So, it might have been better to just say, well, until we’ve got the design sorted, we can’t really tell you how much, I think is probably the real answer here in terms of what’s happening.
TB
It’s as you’re saying, we don’t know how the final form will emerge and all those good questions about what a new bill, what’s the split between business and residential? I mean, what do you think would have been an appropriate policy response in this context?
John Cantin
I’m a Libra Terry, so I’d have gone straight down the middle 50/50.
TB
That’s a fair working hypothesis. When the announcement was made, I referenced what had happened in the U.K. But this goes further than the U.K. because the U.K. basically restricted the interest deduction to a basic rate of tax, 19%. But what’s proposed here is much more punitive.
John Cantin
I think that that speaks to the difference in the approaches to the tax system. The U.K. does what I call buckets, you know, separates business from other income. You have different tax rules for different streams of income. New Zealanders for a long time simply said it all goes into your taxable income, the expenses are deductible and it’s all one marginal rate. So, I think those are the differences.
The thinking here is quite different in the sense that it doesn’t look at it necessarily in isolation. It all feeds into the one taxable income number with one tax rate at the end, or marginal tax rate. So, I think that’s the driver.
But I think it’s important that you get the base right in the first place, making sure that you are taxing what ought to be taxed, and that’s a fair reflection of what the income is. So, if you go back to the repeal of building depreciation, I’m not sure that anyone was convinced there was no depreciation at all, apart from some officials in Treasury and Inland Revenue back in the day. They have now retreated from that. But again, we keep working on those base measures to make sure that people are paying tax on what really is income.
TB
That depreciation measure always struck me as a bit strange because the Bob Buckle group did say it was debatable whether it’s proper for residential property, but certainly for commercial property it should be in place.
In relation to the extended bright-line test period, this references a little bit to your point about how the UK approaches taxation, how appropriate is it that gains are taxed at a person’s marginal rate? Should it be a different rate maybe or maybe a person’s average rate over the period the property has been held?
John Cantin
I’ll probably come at that with having listened to officials for too long Terry, is from a framework of this is all income, what you’re really saying is that gain has been accruing over the number of years that you’ve held the property. An economist will say, well, it’s income and should be taxed on an unrealised basis. So, by waiting until you sell it, the Government misses out on the tax it should have collected through all of the years that you held it.
If you sold it year nine, that’s eight years’ worth of gain tax hasn’t been paid on. So if you were to average the rates, then you should probably add an interest factor to that as well to compensate the Government for not having been paid earlier. I know that’s an odd concept because, you know, I haven’t got the income, so why should I pay the tax. But that’s the economist’s view of how income accrues.
Then you start getting into the complications of saying what should the interest rate be and what should the average rate be over those years? From a simplistic perspective, you simply go with the rate that applies in the year the gain is realised.
And of course, the Bright-line test is not the only time we do that. You know, if you happen to get a big bonus in a year that’s out of the ordinary, you still get taxed on that at your marginal rate in that year that you get the bonus. So, it is just one of those features of our system.
TB
It was actually reading about an ACC claim that had been denied and then she got a lump sum payment, which was then taxed at rates well above what would have been her normal rate, that prompted me to ask that question. That’s always struck me as an anomalous treatment in that context. But as you say, it’s built it into the system and that’s the way it stands.
John Cantin
Sometimes we should ask the questions of whether that should be the answer. And it sort of comes back to the article Terry. I think the loophole language is unfortunate and the defence of it in the sense that you can claim the interest deduction I don’t think answers the question because the question is, should you have that interest deduction even though the current law says you can?
And I think you should always be asking the question, albeit you can’t ask it every time of all the thousand odd sections that we have. Is it still the right answer? And as the world changes our answer might change as well.
TB
Well, that seems a very good place to leave it John. I really appreciate you coming on and talking with me. Thank you for being our guest and have a great day.
John Cantin
Thanks very much, Terry. Appreciate it.
TB
That’s it for today. I’m Terry Baucher. And you can find this podcast on my website, website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients until next week, ka kite āno.
24 Apr, 2021 | The Week in Tax
- Inland Revenue targets the construction industry
- The unfair tax treatment of ACC lump sum payments
- The latest OECD data on carbon pricing
Transcript
This week, Inland Revenue launches a construction industry education campaign, an odd case highlights the continuing unfair tax treatment of lump sum payments, the OECD data around the use of taxes on carbon.
On Tuesday, Inland Revenue launched an education campaign for the construction industry. As its press release to tax agents indicated, “The purpose of the campaign is to engage with those in the construction industry, to ensure they’re getting it right from the start and support them in understanding their tax obligations if they undertake cash transactions.”
The release goes on “Our customer research indicates that people are more likely to engage in hidden economy activity e.g., cash jobs, in an environment of economic uncertainty such as the current Covid-19 environment. We want to reduce the risk of this through awareness, education and compliance.”
And what it proposes to do is place Inland Revenue ads around building sites and hardware stores, together with online ads. Now, as part of this, Inland Revenue has put together a website called Rebuild NZ, and it’s to highlight to those in the construction industry how they can ensure they meet their tax obligations as well as doing their bit to help rebuild New Zealand.
Now, this is a useful initiative from Inland Revenue. They do these campaigns regularly. This one actually is quite interesting in that it is tackling the question of cash, jobs and cashies, but it’s not too heavy handed in its approach. Its website’s heading is “Cashies won’t rebuild our country”. So it’s playing on emotional strings. And this is actually quite standard practice now. You notice a play on what’s the consequences of not contributing to the tax take. The website declares every “undeclared cash job hurts our economy and the greater New Zealand.” So it’s really pulling the emotional triggers.
A couple of things of note on that. The website wisely, in my view, points out it’s OK to do cashies. You just need to declare them on your annual tax return. What Inland Revenue is saying is that per se, these aren’t illegal, but they become problematic if you don’t declare the revenue from them.
There will be some persons who, for whatever reason, want to be paid cash. And you can draw your own conclusions as to why they might want that. But if they are following the rules, make the necessary declarations then Inland Revenue is unconcerned, relatively speaking.
The other thing the website highlights here is, and I quote, “Can cash jobs really be tracked”? And it underlines this absolutely, giving the following example.
If two tradies work together, one declares a job, the other doesn’t. They can be dobbed in without realising it. If we audit one person, it might indicate another business or contractor that needs to be audited. Also, there’s always a chance of a random audit. We can see when tradies buy supplies such as paint, carpet or timber without a corresponding declared job. We can also access information held by other government departments, banks, loyalty cards, casinos and many other organisations to make sure all income is being declared.
Interesting reference to casinos in there, because clearly casinos are a place where cash is handy for gambling. And if you’ve read many tax cases down the years you’ll know an excuse for unexplained income is often, “Oh, I got lucky on the horses or down at a casino.”
So what they’re saying is it’s never too late to do the right thing, come forward, make voluntary disclosures, or if you wish, report tax or tax evasion or tax fraud anonymously.
As I said, we’ve seen a number of these campaigns before. As Inland Revenue works through the final part of its Business Transformation programme and gets fully back up to speed we’ll see more and more resources deployed into taxing the hidden economy. The estimate is that it could be worth a billion dollars a year in undeclared GST and income tax.
ACC lump sum tax unfairness
Moving on. A case before the Taxation Review Authority, the tax equivalent of the District Court, caught my eye the other day. A taxpayer had commenced challenge proceedings against the Commissioner of Inland Revenue contesting the tax treatment of a lump sum paid to her by ACC on 9th November 2017. The payment was for weekly compensation due to her for the period from the date of her injury on 22nd April 2014 to 17th September 2017.
The taxpayer contended that the payment should have been treated for tax purposes as having been derived on an accruals basis and spread over the income years to which the payment related, rather than on a cash basis as assessed by the Commissioner.
As you can see, although she received over three years compensation in one sum, Inland Revenue treated it as income for the one year, even though it actually related to nearly three years, and taxed it at the relevant rate. And because of the way the tax system applied, a large chunk of that lump sum would have been taxed at 33%, when in fact probably it would have been taxed at lower rates had it been received when it should have been.
It’s not the first time I’ve seen this. It’s actually something I have raised directly with then Minister of Revenue Peter Dunne almost 10 years ago. It’s a well-known problem of the tax system, that whenever ACC denies a claim or is slow paying out, often the recipients lose out on the tax side of it, because when they finally get the correct amount of compensation, it’s paid as a lump sum and taxed accordingly.
The taxpayer in this case understandably outraged, then tried to take a case through the Taxation Review Authority. And in response, Inland Revenue – the Commissioner – applied for an order striking it out as there was no cause of action as it was clearly untenable and could not succeed. And the TRA agreed there was no tenable prospect of success.
But that doesn’t get past the issue that the taxpayer had a very fair point, and it’s something, as I said, I’ve seen before. And it is frustrating that this continues to happen, and Inland Revenue and successive Ministers of Revenue are inclined to do nothing about it.
In the interests of equity and fairness, this is an issue that should be addressed. By the way, the lump sum taxation of redundancy payments should also be addressed for the same reasons: a taxpayer may normally have their earnings taxed at 17.5%, but instead, when a lump sum, the tax system will tax it at 33%. And now with an increase in the tax rate to 39%, there is a likelihood that an even higher rate of tax – more than double in fact – could apply to a lump sum payment.
So addressing this is well overdue in my mind. But it’s funny, there’s a lot of stuff goes on in the tax world. But basic stuff like this which affects ordinary people, seems to just get left on the “Can’t be bothered” or “Too hard” piles.
Tax threshholds
And interestingly, yesterday an article came out in Stuff, which ties into this. It pointed out how tax rates for those middle-income earners are too high relative to their income because the thresholds have not been adjusted since April 2008.
As Geof Nightingale of PWC and the Tax Working Group pointed out, most attention needs to be paid to the tax rate applicable to middle income earner:
“I think our harshest tax rate isn’t at 39% or 33%. It’s 30%, which cuts in at 48,000 dollars. That’s below the median wage. That jump from 17.5% to 30% in the dollar is a steep one. It seems tough to be hit with that tax rate when you’re earning below the median income”.
I agreed with that, as did Robyn Walker, a partner at Deloitte.
And we also gave examples that if thresholds had been raised in line with wage inflation, the threshold at which 33% kicks in, which is currently $70,000, would probably be nearer to $100,000. And the $48,000-dollar threshold, when it rises to 30%, would be about $67,000.
So the thresholds are now well out of whack. But again, governments of both hues seem inclined to not do much about it or, kick it down the road and pretend when they do something, it’s a tax cut. Something I think they’ve been allowed to get away with for too long.
And that’s why Simon Bridges has put in this private member’s bill to change that. It will be interesting to see what exactly happens to it. You can bet that politics will come into play and what is actually quite a sensible measure will probably be stifled.
Taxes on carbon
And finally, yesterday, 22nd April was Earth Day. And obviously there were a number of events in recognition of that event. As part of the run up to Earth Day, the OECD released a brochure talking about effective carbon tax rates and how the 44 OECD and G20 countries price carbon emissions from energy use.
The OECD points out that carbon pricing is an effective decarbonisation policy because it makes low and zero carbon energy more competitive compared to high carbon alternatives by pricing carbon emissions properly. And it highlights what’s happened in the UK’s electricity sector, which used to be primarily coal and gas fired. The UK has increased effective carbon rates in that sector from seven euros per tonne of CO2 to more than 36 euros per tonne between 2012 and 2018. As a result, emissions in the electricity sector fell by 73% over that time.
And so what the OECD is saying is we should be looking at emission permit prices, carbon tax, or as we do here, an emissions trading scheme and fuel excise taxes. Fuel excise taxes always come with a caveat in that they are very regressive for low-income earners. One of the biggest problems we have with our transport policy here is the fuel taxes will hit low-income earners quite hard, particularly when we haven’t yet developed sufficient alternatives in public transport to enable alternatives
The OECD report wasn’t particularly complimentary about how the top 44 countries have been doing. It notes that three countries, Switzerland, Luxembourg and Norway, have reached a carbon pricing score rated on 60 euros per ton, which is the price expected by 2030 to be needed for carbon decarbonisation. Those three countries are close to 70% on that. And that’s mainly because of fuel taxes on the road sector.
But elsewhere, progress is patchy. Brazil and India are right down at one end of the scale. The USA is at 22%. New Zealand sits roughly just below the average at 33%.
There’s a lot of work to do and as we know, we’re now starting to get into the debate led by the Climate Change Commission as to how we deal with this matter. Tax is going to play a part in that.
As I said, fuel taxes are a problem for until we develop adequate alternative transport policies, public transport. Building more roads doesn’t help because that actually increases emissions. But the infrastructure deficit New Zealand has needs to be addressed and, tax will play a part in this.
As I’ve mentioned before, I think fringe benefit tax on high emission vehicles, as they do in the UK and Ireland, is something that we should be looking at. But I also feel very strongly that any taxes raised by this should be recycled back into ameliorating the impact for those who cannot choose alternatives to using their car.
Well, that’s it for today. Next week, I’ll be joined by John Cantin, a tax partner at KPMG who made some very interesting observations about the tax policy process and implications of the recent property tax proposals. We’ll be discussing this and the implications for the Generic Tax Policy Process.
I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week Ka kite āno!
17 Apr, 2021 | The Week in Tax
- Cryptoassets under the spotlight
- 10 years of compulsory zero rating for land transactions
- A warning for trustees moving to Australia.
Transcript
New Zealand houses aren’t the only asset class that has exploded in value over the past 12 months. A report by the Secretary General of the OECD to the G20 finance ministers and central bank governors in Italy earlier this month noted that since he last reported to them in February 2021, the overall market capitalisation of virtual currencies has gone from just over US$1 tln to US$1.8 tln.
Now, quite apart from that near 80% increase, the growth has been almost five-fold since September 2020, when the market capitalisation was US$354 billion.
There are two things to note about this fantastic growth in value. Firstly it is going to attract keen interest from the tax authorities who will want their cut of the gains that have arisen. And of course, the tax authorities are still struggling to keep up with the pace of change in this sector. And Inland Revenue is no different from the rest.
There are some rulings in preparation at Inland Revenue including an updated release on how it views the treatment of cryptoassets. But its general position remains that cryptoassets will be taxable, with rare exceptions on the basis that rather akin to gold bullion, the value can only ever be released by sale, so therefore they must have been acquired with a purpose or intent of sale.
The thing is though, the whole cryptoassets sector is rapidly becoming ever more complex and new instruments are being developed, which point to Inland Revenue’s argument as not necessarily being sustainable. So that’s one point that people must be noting when preparing their tax returns for the year ended 31 March 2021. Now I’m sure we will see people coming forward who have substantial cryptoassets gains and are wishing to make the right tax declaration.
But the other matter, which is of concern to tax authorities, is trying to keep track of all of this. As is well known, the OECD has developed in recent years the Common Reporting Standards on the Automatic Exchange of Information. And what the Secretary General for the OECD said in his tax report to the G20 finance ministers and Reserve Bank governors, is that the OECD is designing a “tax reporting and exchange framework that will address the tax compliance risks associated with the emergence of cryptoassets and reflecting the crucial role the crypto exchanges play as intermediaries in the cryptoassets market.”
Now, the proposal is that basically they want to bring cryptoassets into the common reporting standards and in exchange for information. So that’s going to be quite complicated. One of the attractions of cryptoassets is they are supposedly off the grid or under the radar of the tax authorities, and, how shall we describe it, that the reporting requirements are a little bit more relaxed.
Anyway, the OECD is preparing detailed technical proposals on this, on a new tax reporting framework. And it is intending to deliver a proposal to the G20 later this year. As usual, we’ll bring you news on that when they when it happens.
After ten years, there is still confusion
Moving on, it is 10 years since compulsory zero rating of land transactions was introduced. From 1st of April 2011 most sales of land and buildings between GST registered persons became zero rated for GST purposes under what we now call compulsory zero rating provisions. If these apply, then the land transaction must be zero rated.
Now the provisions were introduced to prevent what was seen as a trend towards “Phoenix fraud”, whereby a vendor did not pay output tax on the sale of property to Inland Revenue but the purchaser claimed a GST refund. The suggestions were that the annual loss in GST was in the tens of millions of dollars.
Now, it’s important to note that this is between GST registered persons and what it did was fundamentally shifted the GST risk on transactions involving land buildings from Inland Revenue to the parties involved. And as an excellent little report on the matter from PWC points out, that wasn’t always fully appreciated by parties to transactions, particularly those who were seeking to claim an import tax deduction on the purchase.
After 10 years these rules should be relatively well known now. However, there’s still quite a lot of issues emerging on that. And I regularly encounter the issue where a GST registered purchaser has bought land from what they understood to be an unregistered person, only to find out afterwards that the vendor either is or should have been GST registered. Now that often comes up when they file a GST return and claim the input tax credit. Now, the result is they don’t get any input tax credit and that purchaser is understandably very upset. The last such case I handled the vendor finished up paying almost $400,000 as a consequence of getting that GST status wrong.
And it seems surprising this should be happening because the standard sale and purchase agreement does have specific provisions on the whole schedule declaring the GST status of the parties involved. I mean, one of the risks is that the GST position of one party depends on the GST profile or information of the other party. So it’s not often that that level of tax detail is required in tax transactions, but they are for compulsory zero rated land transactions.
The report from PWC has useful little tips for vendors and purchases. But the key point it makes is parties have got to take extra care with this. They’ve got to make sure that the GST status of both parties is absolutely clear and understood at the time the agreement was entered into. Otherwise subsequently, it gets very messy and expensive and the only people who win are lawyers and accountants with fees, trying to sort out the mess. Inland Revenue is quite happy about all of this because, as I said earlier, it has shifted the risk.
So generally speaking, if something goes wrong, it gets its cut and leaves it to the other parties in the transaction to sort themselves out. So again, pay attention if you’re involved in the purchase of land and buildings. It’s a compulsory zero rated transaction for GST purposes. Pay attention and make sure all the Is are dotted and the Ts are crossed.
A warning for trustees
And finally, just another reminder popped up with a new client coming to me this week, with a common issue, and that is the status of trustees who move to Australia.
Now as the Australian tax legislation for income tax purposes, deems a trust to be resident in Australia, if any trustee is a tax resident of Australia. So you could have a trust with seven, nine, 11, whatever number of trustees. But if one of those trustees is resident in Australia, then the trust is deemed to be resident in Australia and the consequences, particularly around capital gains tax, become potentially very severe.
There’s a slight anomaly in this position because often individuals that move from New Zealand to Australia qualify as what the Australian tax legislation calls a temporary resident.
And what that means is rather like our own transitional residence exemption. Non-Australian sourced income and gains are not taxable in Australia, but trusts are not covered, or companies are not covered by that exemption. So there is the situation where an individual who receives a distribution from a New Zealand trust is not going to be taxable on that in Australia, but if he is a trustee of that trust, making the distribution to him or her, then the trust is now within the Australian tax net.
So this new client is a reminder for anyone moving to Australia and they are either a trustee or have a power of appointment over trustees, then they need to resign as the trustee and revoke/transfer that power to another person who is not an Australian tax resident.
Given the sheer number of trusts we have in New Zealand, approximately half a million at last estimate, this is going to be a quite common scenario. So even if it is just a family trust holding a former residential family home in New Zealand, they could well be landed with a whole heap of Australian tax issues.
So anyone moving to Australia should take advice on the tax implications of you doing so and make full disclosures to your advisors. It is like the mess ups we see with the compulsory GST rating and land transactions. It’s astonishing how people are rather casual when explaining their circumstances to their advisers and often with very expensive consequences.
Well, that’s it for today. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients until next week, Ka kite āno.
